NOTE 1 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of Presentation

The accompanying condensed financial statements have been prepared by Gulf Resources, Inc. a Delaware corporation and its subsidiaries (collectively, the “Company”), without audit, in accordance with the instructions to Form 10-Q and, therefore, do not necessarily include all information and footnotes necessary for a fair statement of its financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States (“US GAAP”). The balance sheet at December 31, 2011 is derived from the audited balance sheet but does not include all disclosures required by US GAAP. In connection with the consolidated financial statements and notes included in this report, reference is made to the consolidated financial statements and notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011 (the “2011 Form 10-K”).

In the opinion of management, the unaudited financial information for the quarter and six-month period ended June 30, 2012 presented reflects all adjustments, which are only normal and recurring, necessary for a fair statement of results of operations, financial position and cash flows. These condensed financial statements should be read in conjunction with the financial statements included in the Company’s 2011 Form 10-K. Operating results for the interim periods are not necessarily indicative of operating results for an entire fiscal year.

The preparation of financial statements in conformity with US GAAP requires management to make estimates and assumptions that affect the amounts that are reported in the financial statements and accompanying disclosures. Although these estimates are based on management’s best knowledge of current events and actions that the Company may undertake in the future, actual results may be different from the estimates. The Company also exercises judgments in the preparation of these condensed financial statements in the areas including classification of leases and related party transactions. 

Certain comparative amounts in the accompanying condensed financial statements have been reclassified to conform to the current period’s presentation. These reclassifications had no effect on previously reported condensed net income or stockholders’ equity.

(b) Nature of the Business

The Company manufactures and trades bromine and crude salt through its wholly-owned subsidiary, Shouguang City Haoyuan Chemical Company Limited ("SCHC"), and manufactures chemical products for use in the oil industry and paper manufacturing industry through its wholly-owned subsidiary, Shouguang Yuxin Chemical Industry Co., Limited ("SYCI") in The People’s Republic of China (“PRC”).

As of June 30, 2012 and December 31, 2011, allowance for doubtful accounts were nil. No allowances for doubtful accounts were charged to the income statement for the three-month and six-month periods ended June 30, 2012 and 2011.

(d) Concentration of Credit Risk

The Company is exposed to credit risk in the normal course of business, primarily related to accounts receivable and cash and cash equivalents. Substantially all of the Company’s cash and cash equivalents are maintained with financial institutions in the PRC, namely, Industrial and Commercial Bank of China Limited and China Merchants Bank Company Limited, which are not insured or otherwise protected. The Company placed $71,994,771 and $78,526,060 with these institutions as of June 30, 2012 and December 31, 2011, respectively. The Company has not experienced any losses in such accounts in the PRC.

Concentrations of credit risk with respect to accounts receivable exists as the Company sells a substantial portion of its products to a limited number of customers. However, such concentrations of credit risks are limited since the Company performs ongoing credit evaluations of its customers’ financial condition and due to the generally short payment terms. About 84% and all the balances of accounts receivable as of June 30, 2012 and December 31, 2011, respectively, are outstanding for less than three months. The remaining 16% of the balances of accounts receivable as of June 30, 2012 are subsequently settled.

(e) Property, Plant and Equipment

Property, plant and equipment are stated at cost less accumulated depreciation and any impairment losses. Expenditures for new facilities or equipment, and major expenditures for betterment of existing facilities or equipment are capitalized and depreciated using the straight-line method at rates sufficient to depreciate such costs over the estimated productive lives. All other ordinary repair and maintenance costs are expensed as incurred.

Mineral rights are recorded at cost less accumulated depreciation and any impairment losses. Mineral rights are amortized ratably over the term of the lease, or the equivalent term under the units of production method, whichever is shorter.

Construction in progress primarily represents direct costs of construction of plant, machinery and equipment. Costs incurred are capitalized and transferred to property and equipment upon completion, at which time depreciation commences.

The Company’s depreciation and amortization policies on property, plant and equipment, other than mineral rights and construction in progress, are as follows:

		Useful life (in years)
Buildings (including salt pans)		8 - 20
Plant and machinery (including protective shells, transmission channels and ducts)		5 - 8
Motor vehicles		5
Furniture, fixtures and equipment		8

Property, plant and equipment under capital leases are depreciated over their expected useful lives on the same basis as owned assets, or where shorter, the term of the lease, which is 20 years.

(f) Retirement Benefits

Pursuant to the relevant laws and regulations in the PRC, the Company participates in a defined contribution retirement plan for its employees arranged by a governmental organization. The Company makes contributions to the retirement scheme at the applicable rate based on the employees’ salaries. The required contributions under the retirement plans are charged to the consolidated income statement on an accrual basis when they are due. The Company’s contributions totaled $112,275 and $105,537 for the three-month periods ended June 30, 2012 and 2011, respectively, and totaled $242,393 and $226,912 for the six-month periods ended June 30, 2012 and 2011, respectively.

(g) Revenue Recognition

The Company recognizes revenue, net of value-added tax, when persuasive evidence of an arrangement exists, delivery of the goods has occurred, customer acceptance has been obtained, which means the significant risks and ownership have been transferred to the customer, the price is fixed or determinable and collectability is reasonably assured.

(h) Shipping and Handling Fees and Costs

The Company does not charge its customers for shipping and handling as all customers arrange their own transportation of finished goods. The Company classifies shipping and handling costs for purchase of raw materials as part of the cost of net revenue, which amounted to $0 and $167,657 for the three-month periods ended June 30, 2012 and 2011, respectively, and $80,607 and $281,228 for the six-month periods ended June 30, 2012 and 2011, respectively. Such shipping and handling costs for purchase of raw materials are borne by the suppliers since April 2012.

(i) Exploration Costs

Exploration costs, which included the cost of researching appropriate places to drill wells and the cost of actual drilling of potential natural brine resources, were charged to the income statement as incurred. For the three-month and six-month periods ended June 30, 2011, the Company incurred exploration costs in the amount of $3,867,286, in Sichuan province, PRC, for the drilling of exploratory wells and their associated facilities in order to confirm and measure the natural brine resources in the area of drilling. The Company completed the drilling of exploratory wells in December 2011 and received a testing report in mid-January 2012 which confirmed the underground brine water resources.

(j) Recoverability of Long-lived Assets

In accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 360-10-35 “Impairment or Disposal of Long-lived Assets”, long-lived assets to be held and used are analyzed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable or that the useful lives of those assets are no longer appropriate. The Company evaluates at each balance sheet date whether events and circumstances have occurred that indicate possible impairment.

The Company determines the existence of such impairment by measuring the expected future cash flows (undiscounted and without interest charges) and comparing such amount to the carrying amount of the assets. An impairment loss, if one exists, is then measured as the amount by which the carrying amount of the asset exceeds the discounted estimated future cash flows. Assets to be disposed of are reported at the lower of the carrying amount or fair value of such assets less costs to sell. Asset impairment charges are recorded to reduce the carrying amount of the long-lived asset that will be sold or disposed of to their estimated fair values. Charges for the asset impairment reduce the carrying amount of the long-lived assets to their estimated salvage value in connection with the decision to dispose of such assets.

For the three-month and six-month periods ended June 30, 2012, the Company determined that no further impairment were required after going through the impairment testing to the operating long-lived assets (property, plant and equipment, both owned and under capital leases, net). For the three-month and six-month periods ended June 30, 2011, the Company made impairment of long-lived assets for the relocation of Factory No. 4 and idle plant and machinery in the amount of $3,873,087.

(k) Basic and Diluted Net Income per Share of Common Stock

Basic earnings per common share are based on the weighted average number of shares outstanding during the periods presented. Diluted earnings per share are computed using weighted average number of common shares plus dilutive common share equivalents outstanding during the period. Anti-dilutive common stock equivalents which were excluded from the calculation of number of dilutive common stock equivalents amounted to 2,906,971 and 1,378,847 shares for the three-month periods ended June 30, 2012 and 2011, respectively, and amounted to 2,175,548 and 241,002 shares for the six-month periods ended June 30, 2012 and 2011, respectively.

The following table sets forth the computation of basic and diluted earnings per share:

	Three-Month Period Ended June 30,				Six-Month Period Ended June 30,
	2012		2011		2012		2011
Numerator
Net income	$	5,688,674	$	10,023,255	$	8,975,781	$	24,388,254

Denominator
Basic: Weighted-average common shares outstanding during the period		34,560,743		34,729,179		34,560,743		34,732,527
Add: Dilutive effect of stock options		-		4,009		651		395,746
Diluted		34,560,743		34,733,188		34,561,394		35,128,273

Net income per share
Basic	$	0.16	$	0.29	$	0.26	$	0.70
Diluted	$	0.16	$	0.29	$	0.26	$	0.69

(l) New Accounting Pronouncements

No accounting standards and guidance with an effective date during the three-month and six-month periods ended June 30, 2012 or issued during 2012 had or are expected to have a significant impact on the Company’s condensed consolidated financial statements.